Safeguarding Beta with Stewardship | Raj Thamotheram | Preventable Surprises

To paraphrase Winston Churchill - who was talking about the Americans and WW2 - you can always trust the investment industry to do what's right, after it has exhausted every other possibility!

Focusing on HOW to do stewardship better before asset owners really understand WHY this is important is yet another version of the same game. Practically all fund managers and investment consultants now have in-house expertise on what they need to do or they know where to get it. What's missing is assertive and informed client demand, and at scale.

Asset owners who are long horizon and well diversified primarily depend on the market return - the beta - to match their liabilities. The alpha is the icing, or perhaps even the cherry, on the cake. So what's the best thing that investors can do to safeguard and enhance the beta? It's stewardship.

You've put your finger on a big reason why funds are focused on the wrong thing - chasing alpha and beating benchmarks. What happens in our individual lives when we focus so much on less important things? Of course, we "don't have time" for what's really important.

As you well know through your own work, there is no such thing as an "average" asset owner. There's a huge variation in AUM and also attitudes to outsourcing. If, for example, a sovereign wealth fund or large public pension fund with a significant front office team doesn't think it can do stewardship properly, this says a lot about the mental models of the senior executives and board. On the other hand a small asset owner which is heavily dependent on service providers should probably continue that approach with the stewardship function too. And for many funds, it makes sense to have an ESG stewardship specialist inhouse to help sensitise and monitor the traditional investment professionals be they inhouse and or external.

As with all fiduciary duties, even if delegated, trustees are responsible. If they do have that know how on the board, they need to appoint a staff member or consultant who does. That specialist should be held accountable for their decisions. For example they should either use an established ranking of stewardship competence (e.g. the ShareAction ranking) or should have their own bespoke approach (which they should justify as being superior).

EOPs are often excellent sources of stewardship expertise but they are currently misdirected. I've previously used, a bit tongue in cheek, the analogy of the difference between a sex worker and a sex therapist. Both have specialist technical knowledge but serve very different purposes. The former are often used as a replacement option when relationships have failed. The latter can help partners re-establish trust and learn together how to satisfy their requirements. This is what EOPs should be doing in my opinion and would like to do if enough clients wanted this.

There are three mega and crosscutting stewardship themes that demand acetone attention today the first of interconnected climate and biodiversity crises. Second is income in the quality and the political polarisation this produces. And third is the corporate capture of politics and regulation. I'd recommend that all asset owners focus on these three issues, whatever else they do. Particular asset owners may have specific topics that connect with their organisational mission. For example a pension fund for health workers may want to pay attention to how it relates to tobacco and alcohol companies.

I remember talking to a very large sovereign wealth fund who told me all seriousness that the "only own 3% of company X" and therefore couldn't have any real impact! "AUM envy" is another game that some asset owners like to play. Seeing that it's a way to avoid responsibility is the first step to accepting accountability. That said, it is true that asset owners need to be focused on real world impact. and that means going back to their mental models and theories change. For example, if they only use an index manager, then they should partner with similar asset owners, first to really understand the different performance of these managers and then either engage with their preferred manager (to get them to improve) or move their money (ie make stewardship as important a criteria as, say, cost when awarding new mandates). Of course these are not alternatives – making public a decision to do the latter has a very powerful engagement effect.

As with all aspects of core organisational culture, stewardship starts at the top. Either the chair of the trustee board (and also the chair of the investment committee, if one exists) needs to be "stewardship competent" or he or she needs to appoint someone to play that role at board level. This may need the board to refresh its DNA and ensure this is an on-going development priority. This is the most important thing that an asset owner can do - the allegory of the hare and the tortoise definitely applies! Instead, many asset owners procrastinate and then jump to either delegating stewardship to an existing (and potentially stewardship incompetent) investment consultant or appointing a junior ESG professional, several layers down from the senior management team. This is yet more distraction activity to be avoided. The pension fund members would be much better served if the trustees spent two or three committee sessions or an away day really understanding the 3 mega systemic risk that I raised earlier - and how these are already impacting on current and future beneficiaries (ie likely scenarios). Internal conflict (ie between the trustees) is one reason why readers consider this advice impossible. If so, I'd suggest the concerned trustees invest in becoming even better advocates for change and building the internal and external alliances needed to be successful. This is also stewardship!